My not-so-profound thoughts about valuation, corporate finance and the news of the day!

Thursday, September 22, 2011

The Buffett Plan: An apt name for a sanctimonious, hypocritical and superficial proposal

At the start of this week, President Obama laid the groundwork for his deficit plan, with one of the proposals being what he termed the "Buffett" tax. Like Bank of America, a few weeks prior, he was perhaps hoping to borrow on Buffett's credibility to increase support for his plan. Put briefly, here is the what the plan is designed to do. Taxpayers who earn more than a million dollars will be required to pay at least as high a tax rate as what the average tax payer pays. What constitutes a average taxpayer (I guess it is a good thing that it is not the median taxpayer; since that would comprise an income tax cut for millionaires, not a tax increase) and how high this "alternative" tax rate should be has been left to Congress to specify.

This plan has the right moniker, since it's qualities are reflective of the man after whom it is named:

It is sanctimonious: The word that best comes to my mind as I read Buffett's views on investing and business is "sanctimonious". He is the noble CEO, who puts stockholders' interests first, in a world full of cynical, self interested CEOs. He is the keeper of the value investing flame, while those short-term money managers in New York and London have abandoned Ben Graham, fundamentals and first principles. He is the brilliant financial thinker, standing alone against those clueless academics and their betas & option pricing models. In his latest foray, he is the "good" billionaire, who wants to pay his fair share of taxes, unlike those bad ones who shirk paying their share. This tax plan echoes this refrain. In effect, it says, the details don't matter because the intentions are noble: the rich can not only afford to pay more in taxes but they should be happy to do so.

It is hypocritical: All this sanctimony might be tolerable if it came from someone who not only talks the talk but walks the walk. Warren Buffett is a hypocrite on many of the issues that he is most vocal on. Consider corporate governance. The same man who said that managers are stewards of their shareholder capital has not always followed his lead, in structuring and running his own company. First, Berkshire Hathaway has adopted the dual-voting share plan that has been the weapon of choice for entrenched insider control in other companies (See New York Times, News Corp, Google, Washington Post... ). Second, while I admire Buffett's frugality, I don't see any transparency at Berkshire Hathaway. In fact, it looks to me like the board at the company exists to rubber stamp whatever Buffett and Munger want. A case in point: look at the successors that have been hired to take Buffett's place: Ted Wechsler (his recent hire) and Todd Combs. Both seem like nice men with, but we know little about them (other than the fact that Buffett and Munger like them). One of the few data points we have on Wechsler is that he was the winning bidder, two years in a row, paying $2.6 million each year, in an auction where the prize was lunch with the Oracle from Omaha. If you see nothing wrong with that, you should be okay with Bob Iger picking his successor for Disney from a Mickey Mouse look-alike contest or Steve Ballmer choosing the next winner of the hot dog eating contest at Coney Island (Was that Joey Chestnut?) as the CEO for Microsoft. Third, for those who argue that Buffett can be trusted to make these judgments, I do remember that he did hand-pick his last successor and that did not end well, did it? No one is impervious from making mistakes, but people who live in glass houses should not throw stones.

This tax proposal is just as hypocritical. While it is couched in terms of fairness, it is based on a false argument: that millionaires pay less in taxes because they exploit massive tax loopholes and have very good tax lawyers. While there may be some who do, we know why the effective tax rate for millionaires is so low. It is because a significant portion of the income comes from capital gains and dividends, which are paid out by corporations from after-tax income, and taxed at a lower rate than ordinary income (from wages and profits). I would have had much more respect for the proposal if it had directly confronted this issue. Should investment income be taxed at a lower rate? Should we be taxing consumption or income? That would be a debate worth having.

It is superficial: To be honest, there is really no tax proposal, because the key details of the proposal, the "average" tax payer and the "millionaire minimum tax rate" are not specified. That is very much in keeping with the Buffett rule book. I know that much has been made about the brilliance and home-spun wisdom of Buffett's aphorisms. But as I read the letters that he has written to his stockholders (which comprise the heart of his writing), I am left with the feeling that when Buffett wanders from his preferred habitat - talking about investing in and managing mature companies - there is less there than meets the eye, especially when it relates to macro and market issues. What seems profound and wise at the first reading seems less so with each subsequent reading. Put differently, when it comes to a great deal of investing wisdom, Buffett's sayings seem to draw more on the fortune cookie tradition than from Confucius.

As far as this tax proposal goes, it looks like it was conceived by a union of a rogue economist and an over-the-top populist. (Perhaps, it was.. Has anyone seen Robert Reich and Paul Begala hanging out together?) It will, without a doubt, make the tax code more complex. As a taxpayer who has had to deal with the effect of capped itemized deductions and the alternative minimum tax rate (AMT) for the last decade, I think that they rank among the worst tax code abominations ever, and this proposal is more of the same, just directed at millionaires. It will also be ineffective. The administration estimates that it will raise $ 400 billion in tax revenues from the Buffett tax, which strikes me as unlikely. First, since the "millionaire tax rate" is unspecified, the fact that they can estimate revenues from it reveals exceptional brilliance. Second, since much of the income that will be taxed comes from dividends/price appreciation in the stock market, it would require a rising market and healthy economy.

Am I being unfair in using a tax proposal named after Buffett to attack the man? Perhaps, but this tax proposal has its roots in Buffett's assertion that the rich don't pay enough in taxes and I am sure that the administration got his permission to attach his name to it. To those Buffett acolytes who are upset at my critique of the master, I have a simple suggestion. There are plenty of people, websites and books that revere the man and write puff pieces about him. Why not stick with those? Warren Buffett is a savvy investor, who has an uncanny ability to spot weakness and take advantage of it. I admire his skill but that does not mean that I have to treat him as infallible or exalt everything that has his name attached to it as good. My view is that the "Oracle from Omaha" no longer fits and that we need to come up with something better. I like the "Nag from Nebraska", the "Berkshire Bloviator" and the "Hypocrite from Hathaway", but I am sure that you can come up with your own variations. Any suggestions? (As some of you have pointed out, this last part is over the top and unnecessary. So, let me retract it but leave it up so that I am not erasing history.. But I stand by my overall thesis.)

29 comments:

It is interesting to look at the US personal tax system from Australia, where we have been comparatively sheltered from the impact of the GFC (although we do have a 'two-speed' economy - mining states booming whilst non-mining states not so much).

Our top marginal tax rate is 48%, and applies from A$180,000. No joint filing i.e. no income splitting.

We pay 10% goods and services tax on most things.

Capital gains receive concessions (only a portion of the capital gains is taxed), and dividends can be franked (i.e. you get a credit for the company tax already paid).

But the capital gains and dividends are taxed at marginal tax rates.

And no tax deduction for your mortgage (but you can negatively gear say a share portfolio or investment property).

Seems the US is far more generous to its income earners. And MUCH less compassionate to those not so well off.

Hamish,I am not arguing about whether to raise tax rates on millionaires but how you do it. I would prefer an honest proposal - higher marginal tax rates on both ordinary income and capital gains for high income earners, just like Australia - that can be debated. This proposal, though, is not only deceptive (it tries for backdoor ways to raise taxes by limiting deductions and having an alternative tax rate) but complex and ineffective. So, you choose to live in Australia because it is more compassionate with its less fortunate. Just hope that in today's global economy, your more fortunate don't decide to uproot themselves and move to Singapore or Hong Kong.

I respect your knowledge in securities valuation. I'm a reader of your blogs and writings. I've used ...rather tried to use your models as well.

So, Let me start, thinking you for your contribution to society and throwing light on quite a few dark patches on the valuation route

Having said that, I feel it is below your dignity and below the dignity of a professor to start name calling or pseudo name calling like you have done in the last few lines of this blog post

I still respect your knowledge, I agree that divergent views are needed for a healthy debate and I respect freedom of opinion, but let not those freedoms lower a respected Professor's image and standing in society

You are right. Academics are quite frequently perfectly right...in theory.

Just as betas and option pricing models look awesome on paper and in simulations but are not as successful in practice (these Nobel-winning LTCM guys permanently stained the pure scientific approach to investing and Graham's followers are, mildly put, putting strain on EMT), so is your idea about a honest, debatable tax proposal.

Even the most honest, level-headed and clear-cut proposal will get muddled down and debated to its demise by the politicians we have. There is too much debating going on and not enough agreement and action. This will be the mark of Obama's presidency - lots of talk and not much done.

Maybe it is better, to use this abused phrase, to restore confidence. Make people less upset about the wealth gap. Show them that the rich are not beyond reach.

The human element is important but often omitted from scientific models because it does not let itself to scientific formulation.

Even though the measure may be far from perfect, it may help soothe the soreness and may actually help cut the deficit, while saving the debating for later improvements to the rule.

What I want to say is, I guess: It is better to be roughly right than precisely wrong.

Buffett's proposal is morally right (you say populist). Those better off ought to help the less fortunate. In what way, how much and who exactly is more/less fortunate is always going to heat up the pot. However, the implementation and execution part is the politicians' responsibility, which we can only wish they took as seriously and performed as well as Buffett did and does for his shareholders.

Parts of this attack make no sense at all, and seem to me to say more about Prof. Damodaran than about Mr. Buffett.

How is Buffett “sanctimonious” because of his being noble, financially brilliant, good and the keeper of the value flame? That's being good and smart, not “sanctimonious”. If Buffett is sanctimonious because of his not hiding his goodness, you're being even more so by insisting that he do.

And you can't seriously think Ted Wechsler's appointment is analogous to choosing Bob Iger's successor from a Mickey Mouse look-alike contest. Unless, of course, the winner of that contest also happened to have an extraordinary record as a CEO. (Another of the "few data points" we have on Weschler is his investing performance).

I am a hugh admire of Warren Buffett and all the top Value investors. That being said I found your post to be enlightening. You hit the points dead on the nose.

Too many people look at Warren Buffett as a God which he isn't.

After rereading the Security Analysis and Intelligent Investor for the 5th time each, I realized Buffett took the idea of using a company to purchase other great business from Ben Graham. If you read Security Analysis Graham lays it out.

I am a little disappointed in this post too. 1) Buffett makes a point that the tax code is skewed to the benefit of the wealthy. 2) Obama Admin proposes a tax that targets the uber-wealthy (fairly/unfairly- certainly up for debate). 3) This blog post disagrees w/ the tax proposal but focuses on blasting Buffett on mostly-unrelated issues.

Heck, I'm generally an Obama supporter, but shouldn't your ire be directed to the designers of proposal (vs. the name on the bill?)

If i were at the helm, i'd want something similar to what i believe the "gang of six" (and maybe even the Bowles-Simpson commission) proposed: ~Congress should lower marginal tax rates but raise effective tax rates. Taxes should be based on amounts more than sources. Just my opinion.

Warren is certainly not perfect but he is one of the very few people in the United States corporate world who own a ton of equity in their company, doesn't have a bunch of consultants to figure out how much he and the people he manages should be paid, doesn't have outsized pension fund assumptions, etc... I could go on and on.

Try naming one CEO of such a large corporation who pays himself a $100,000 salary and takes no stock options. Name one CEO who answers his shareholder questions for approximately 5 hours at the shareholder meeting.

You're right, academics are foolish for believing in the strong form of the efficient market theory, they are foolish for thinking that beta(volatility) equals risk, that humans consistently make rational decisions. The truth hurts doesn't it? The one arm man with the hammer quote is apt here.

Interesting you ignore the exceedingly fair comp plan for Todd Combs and Ted Weschler or how you don't mention that "According to Fortune, anyone investing in Peninsula in early 2000 had a total gain of 1,236 percent as of the end of this year's first quarter."

Find me one source from Berkshire itself or one quote from any interview of Warren that says David Sokol was the heir apparent, or indeed where anyone was mentioned by name.

Why be fair to the man? It's obviously much easier to write a one sided hack job.

"A case in point: look at the successors that have been hired to take Buffett's place: Ted Wechsler (his recent hire) and Todd Combs. Both seem like nice men with, but we know little about them (other than the fact that Buffett and Munger like them). One of the few data points we have on Wechsler is that he was the winning bidder, two years in a row, paying $2.6 million each year, in an auction where the prize was lunch with the Oracle from Omaha. "

We also have another "data point": Weschler's track record of returning 1,236% from 2000 to Q1 2011:

Did you really have to post this rant that belongs better on a yahoo message board than on an NYU professor's blog? I can respect the criticism of Buffett for his views on taxation and politics, and even appreciate your disagreement with him on matters of corporate governance. But your post was over the top and disrespectful of the man; for instance, your comparison of the hiring of Weschler to Iger hiring the winner of a Mickey Mouse lookalike contest or Ballmer hiring the winner of a hotdog eating contest was utterly ridiculous.

I have found your work on valuation very useful in my investing life, and I very much appreciate your generosity in making it freely available. So it was particularly sad to see this sorry effort on your blog.

I have to agree with other commenters that the comparison between Wechsler's hiring and a Mickey Mouse look-alike contest is flawed.

The point of the charity auction was...if you guessed "to raise money for charity" due to the prior adjective, congrats! It was not to find a successor. If Bob Iger found a brilliant fantasy-image curator / businessman in a Mickey Mouse contest, I think he should certainly hire him. If Steve Ballmer were to find a brilliant technical mind with huge leadership capabilities in the Coney Island hot dog eating contest, then yes, hire him. If at a charity auction Warren Buffett finds a highly successful hedge fund manager when he is in a need of a person to manage some of Berkshire's money? Just let him walk away? Just because he donated $5 million to eat with Warren Buffett, that disqualifies him from being evaluated for a potential hire?

Perhaps you should stick to finance and skip the logic lessons, because I do agree that the tax code is highly inefficient and simplifying it would be much more of a boon to the nation, but I don't agree that you have the logical capabilities to make this simple analogy.

I have some friends at Stern now, and I hope for their sakes your teaching is better than your writing.

Perhaps that last part was too harsh and I should put a line through it...

Well, the hornet's nest has been stirred.. and I am sure that I have pissed some of you off but I want to respond to at least some of your comments before I move on:1. The man and the plan: Many of you have taken me to task for not separating the man from the plan. If the tax plan had been serendipitously named after Buffett, I would be guilty as accused. In this case, though, Buffett provides the inspiration for the plan, willingly assented to having his name attached to it and is now actively involved in a political process (raising money for the next presidential election) pushing the plan. Once you do that, your fingerprints are all over this plan and you claim to be above the fray. Ask the other billionaires, the Koch Brothers and George Soros, whether they have been given a free pass in the political game.2. Sanctimony: Blanca (one of the posters above) argues that Buffett cannot be sanctimonious because he is good and noble. You can be good and noble and sanctimonious at the same time: all you have to do is note how bad and ignoble the rest of the world is. In my view, the announcement that Berkshire Hathaway made that their new hires (Combs and Wechsler) would receive all their income as ordinary income is an example of sanctimony. It is clearly meant to draw a contrast with those bad CEOs who receive their compensation in capital gains.3. Hypocrisy: Many of you have argued that I withheld a key data point on Wechsler, one of Buffett's new hires and you may be right on this one. The news stories that reported his hiring also notes that his hedge fund made 1236% over the last 11 years, but I was suspicious on two grounds. The first is that the sourcing was "according to some investors" and I was unable to find the returns on the fund over the period and in individual years. The second is that even if the fund generated 1236%, I would like to know the details over the period. But I should have mentioned it.. As to Wechsler winning the charity auction, I should have been clearer about why I brought it up. It is not that he bid $2.6 million for lunch. That is his prerogative, but it is an indication of how opaque this process is that this story was front and center in every news report. But, let's assume that Wechsler has a good track record. It seems quite clear that these men were Buffett's choices. But Buffett is not picking portfolio managers to manage his personal wealth but for Berkshire Hathaway. The last time I checked, Berkshire Hathaway was still a public company, with a board and plenty of stockholders not named Buffett. (And Ryan, neither Bob Iger nor Steve Ballmer would be allowed to pick their own successors. That is the job of the board of directors at these companies, acting in the best interests of stockholders). 4. Rant and tone: Veejar, I am sorry you are disappointed in this post, but I don't buy into your argument that this type of post belongs on a Yahoo message board and not on a blog. But blogs are for expressing personal opinions, and this is mine. In fact, what might separate a rant from a brilliant opinion piece is whether you agree with it. Here is my parting question for those of you who are disturbed by this post. If someone other than Warren Buffett (you put in the name: John Paulson, David Einhorn, David Koch, George Soros) did and said the things that he does and says, would you cut him this much slack?

You are right about the sanctimony – I change my mind. Although I think sanctimony is a pretty poor criterion for judging CEOs, investors, or plans.

Your point about the opaque successor selection process is valid, although the bit about the Micky Mouse contest was misleading, because it seemed to imply Buffett chose Ted Weschler for bad reasons. Personally, as a Berkshire shareholder, I’m fine with Buffett choosing his successor (BookAddict’s comment above explains why), and we do know Ted Weschler met the board before being appointed. If that’s not good enough for you, we can disagree on that.

Bookaddict,The best stock picker of this generation may not be the best "person" picker of the generation.. and that was my point. Perhaps, Mr. Buffett picked the right person and perhaps the board was more involved from the outset, but the process is too opaque to tell. And I am glad as a Berkshire Hathaway stockholder, you are okay with that.. But that does not take away the need for transparency in the process.

Well if that is so, why the hell do all these practicians go to Universities like NYU, Harward or for that matter Columbia before they start out with their practical life....n why is that Practicals end up in a lehmen like situation time and again when they throw out theory out of the window..

I am/was a big follower of Buffet but his recent deals make me feel ... he is no different although he is super smart rather than stupid like most practicianers.

- The bank of America, GE, GS deals are testimony to that, where he ends up up making lots of money and the investors who follow him are left with losses...look at the share prices where they trade today.... on top of that he tells them these are good companies at low valuations...

I think ithis is finally being reflected in the share price of his company berkshire hathway....

All i want to say is that Buffet should have been above all this having made a repuation and money for such a long period of time...markets are about transparency, honesty and business strenght in the long run... and thats what buffet stood for until now...... i don't think thats the case any more!

All valid points, though as an erstwhile observer of both the Professor and Buffett, it's unfortunate that the message here gets diluted by the tone and hyperbole. The madras, as one poster calls it, won't see beyond the characterizations to the legitimate issues.

Shifting from that, I would think that an interesting 'valuation exercise would be the value of Buffett's 'contributon' to Obama here. Is there net value creation, or net deterioration?

By accepting naming rights to what assuredly would have been the 'Obama Tax' - something probably only Buffett could have gotten away with, Buffett spares Obama of a nasty label into the next election cycle, and perhaps into the next generation. It may stick, and this new AMT that will likely be cursed by future generations will be attributed, in the common language, to Buffett as much as Obama. The details will have been long forgotten.

Even into this next election, it's a valuable deflection. Looking at Buffett, he's been working hard on this reputation thing diligently ever since Train's book put him on the public radar - three decades now. This may be an expensive hit for him, although short-term, it may not be as much as the benefit to Obama.

But there are other parties - notably Berkshire shareholders. Whatever our politics, this is a 'value' expenditure. What is the value of that impairment?

Enquiring minds... (etc)... What's the value impact? How much is this contribution worth? How much did it cost? And who paid for it?

Wow! great to see that Prof. retains the anguish over doublespeak that we let go beyond our teenage years. But then, investing and investment banking is a lot about finding a weakness and exploiting it as much as possible, rather finding a chicken and wringing its neck to make it your dinner. When we admire great investors, may be, we implicitly accept teir crass opporutunism and hypocrisy.

I have admired Buffet for a very long time. His focus on Moat while investing, which took me a couple of years to understand, is amazing. But I had no idea that he has such dedicated (tempted to say fanatic) following.

A thought had crossed my mind that, since his days in active investing are numbered now, Buffet might be taking risky bets, which he would not have taken during his younger days, to monetise his reputation/brand. Just a thought, dont get livid on this.

"And I am glad as a Berkshire Hathaway stockholder, you are okay with that."

Just couldn't resist trying to discredit my comments by portraying me as a Buffett groupie could you?

I'll take the other side of your argument:

Buffett commented at least twice on his picking of new investment managers. The first was in the 2006 annual letter:

"Frankly, we are not as well-prepared on the investment side of our business. There’s a history here: At one time, Charlie was my potential replacement for investing, and more recently Lou Simpson has filled that slot.

Lou is a top-notch investor with an outstanding long-term record of managing GEICO’s equity portfolio. But he is only six years younger than I. If I were to die soon, he would fill in magnificently for a short period. For the long-term, though, we need a different answer.

At our October board meeting, we discussed that subject fully. And we emerged with a plan, which I will carry out with the help of Charlie and Lou.

Under this plan, I intend to hire a younger man or woman with the potential to manage a verylarge portfolio, who we hope will succeed me as Berkshire’s chief investment officer when the need for someone to do that arises. As part of the selection process, we may in fact take on several candidates.

Picking the right person(s) will not be an easy task. It’s not hard, of course, to find smart people, among them individuals who have impressive investment records. But there is far more to successful longterm investing than brains and performance that has recently been good.

Over time, markets will do extraordinary, even bizarre, things. A single, big mistake could wipe out a long string of successes. We therefore need someone genetically programmed to recognize and avoid serious risks, including those never before encountered. Certain perils that lurk in investment strategiescannot be spotted by use of the models commonly employed today by financial institutions.

Temperament is also important. Independent thinking, emotional stability, and a keenunderstanding of both human and institutional behavior is vital to long-term investment success. I’ve seen a lot of very smart people who have lacked these virtues."

Notice that he mentioned talking to the board about it?

Buffett stated this in the 2007 annual report:

"Last year I told you that we would also promptly complete a succession plan for the investmentjob at Berkshire, and we have indeed now identified four candidates who could succeed me in managing investments.

All manage substantial sums currently, and all have indicated a strong interest in coming toBerkshire if called. The board knows the strengths of the four and would expect to hire one or more if the need arises.

The candidates are young to middle-aged, well-to-do to rich, and all wish to work forBerkshire for reasons that go beyond compensation."

Notice in that quote that the board knew all the candidates so its no like they were unknown.

The point is that he talked to his shareholdersa about it and talked to the board about it. Frankly I have no idea what disclosure would satisfy you.

Now to be fair I think Buffett has made his share of mistakes, he is quite human after all. The most obvious one to me is his purchase of Dexter Shoe. This investment basically went to zero. I also think that the Executive Jet purchase hasn't worked out well so far. He obviously placed too much trust in Sokol and I think the press release announcing his resignation could have been communicated in a better fashion.

BookAddict,I am sorry that you read my statement the way you did. I really did not intend to convey the impression that you were a Buffett groupie, when I said that Buffett's record on corporate governance is for shareholders in Berkshire Hathaway to judge. It is in fact very much in keeping with my overall philosophy that the only constituency that the CEO of a publicly traded company has to keep happy is the shareholders in the company. It is not his (or her) job to keep interested outsiders, society, government or any one else in the loop. If most shareholders in Berkshire Hathaway feel that Buffett has not only kept them in the loop on succession plans but would have modified them, if he faced resistance, then my criticism is moot.

By implication, it seems that Buffett is advocating an increase in tax rates on investments/savings gains (e.g. capital gains, dividends, other?) to in practice equal to earned income tax rates for the reason of "fairness".

There is a hypocrisy in this as far as he has been a huge beneficiary of this "preferential" tax treatment both in his personal finances and in BRK finances (where the bulk of his wealth is sheltered). I would like to see his wealth recast under the logical extension of his implied assumptions. He may not be as smug about this issue if that were the reality. In fact, he may lose his deity status.

Furthermore, he obviously sees the folly of handing government more money, given the choices he has made (to avoid taxes) and his declared decision to donate most of his wealth to a non-governmental organization after his death. His actions are inconsistent with his rhetoric. He could at least write a check to the U.S. and Nebraska Treasuries...then I can at least respect him for putting his money where his mouth is.

I would rather Buffett take some of his "investing analysis skills" and apply it to how government spends money. He would do us all a great service if he could apply his stated analytic standards / measures of efficiency, transparency, and longevity to various aspects of government operations.

Without getting into a debate about what government should be involved in, once the decision is made, are the programs adopted effective in executing their objective / goals? Our problem in this nation is not a lack of revenue, it is the un-quenching appetite of government to spend more money, while operating with a complete lack of accountability and standards to spending commitments already made. Buffett is rather muted on any discussion along this line.